Timing conspired to line up three back-to-back, ground-breaking deals for Merrill Lynch’s Financial Institutions Group, allowing it to clinch 10 firsts in three markets within five days. Geraldine Lambe reports on the team’s many reasons to celebrate.

Scoring a first with a deal always brings a smile to a banker’s face. Scoring several firsts makes the smile almost indelible. But achieving 10 firsts in three deals, across three markets, all executed by the same team within five days of each other warrants a celebration. If that is the case, one Merrill Lynch team must be breaking out the party-poppers.

Not to labour the point, in mid-November, Merrill Lynch’s consecutive Tier 1 trio for Rabobank, Caisse Nationale des Caisses d’Epargne (CNCE) and French Provident chalked up the following:

  • the largest single tranche Tier 1 by a European bank to date;
  • first directly issued Tier 1 by a French bank;
  • first non-dilutive Tier 1 capital offering by a UK insurance company;
  • an inaugural Yankee issue targeted at institutional clients;
  • an inaugural Tier 1 issue;
  • the first offering under the new French class of deeply subordinated securities created in August;
  • the first to meet the UK’s proposed regulatory requirements for innovative Tier 1 capital that align the treatment of banks and insurance companies;
  • the tightest pricing achieved to date by any bank in the institutional markets;
  • the tightest pricing achieved by any bank in the European institutional markets;
  • and the tightest pricing to be achieved by a French bank on an institutional Tier 1 issue.

 

Proof of capabilities

That is not bad going. Amir Hoveyda, managing director of capital markets and financing, Financial Institutions Group (FIG) at Merrill Lynch, says: “To execute three ground-breaking deals simultaneously across three markets really shows the breadth and quality of our structuring, distribution and origination capabilities.”

There was no plan to execute all the deals back-to-back; it just happened coincidentally, says Marc Tempelman, director of FIG origination and responsible for coverage of Rabobank and CNCE. “The discussions about all the deals were begun a long time ago. When three deals all come to fruition at the same time, you just have to execute.”

Pricing was tight. Rabobank came in at 105bp over treasuries, CNCE at swaps plus 84bp and Friends Provident at 197bp over gilts. Rabobank, in particular, dazzled by virtue of being the tightest pricing achieved by any bank in the institutional markets.

Balancing act

“The process of book-building allowed us to tighten our price guidance and squeeze inside outstanding benchmarks,” says Patrick O’Connell, managing director and head of FIG syndicate. “It is a balancing act: if you pitch too tight you fail to build the book and if you pitch too wide you can’t tighten it in. We wanted to retain the quality of the book but to bring those accounts at the wider end of pricing into the more aggressive range.”

Trading in the secondary markets stands as a testament to the team’s pricing accuracy: all three tightened by only two or three basis points.

Considering the specific challenges of positioning each credit to the target investor audience, it was a particularly successful marketing effort. All three books were oversubscribed at pricing: Rabobank and CNCE by 2.5 times, and Friends Provident by a factor of four. Mr Hoveyda says that Merrill put in a lot of ground-work: it was a matter of anticipating the concerns, sensitivities and preferences of each investor group and advising clients on how to present themselves. “But we did have the wind in our back,” he admits. “The structures were also designed to be investor-friendly and each issuer is a strong credit in its own right.”

Three sets of challenges

All three presented different challenges to the team. CNCE’s ground-breaking characteristics – the bank’s first Tier 1 issue, also the first to be undertaken without the use of international branches or a special purpose vehicle, and the first under France’s newly-created class of Deeply Subordinated Securities – meant that it was both a new issuer and a new structure to present to investors.

Rabobank benefits from being the only bank that is rated triple A by Standard & Poor’s and Moody’s, and its $1.75bn Yankee issue (the size of which took even Merrill by surprise, says Mr Tempelman) was only being undertaken to match the dollar assets on its balance sheet; but to the US investor group the bank was aiming for, the institution’s co-operative structure was an alien concept.

“Investors were asking why the bank is so keen to cling to its triple A rating when it may make better use of economic capital to drop down a notch or two. We had to explain the co-operative idea, that looking after its members is the bank’s top priority,” says Mr Tempelman.

According to Mr O’Connell, Friends Provident was a more challenging credit to analyse. The issue was the first hybrid since the insurance company demutualised, and its rating is lower and the size of the business is smaller than some of its peers. But, as with the CNCE issue, complexity was added by the proposed new regulatory approach. “As the first Tier 1 issue by an insurance company, we needed to establish a credible framework that reflected the credit and the structure, both of which were new to investors.”

Jonathan Winstanley, director of debt markets and responsible for structuring hybrid instruments, says: “There was real innovation in each of these deals. Rabobank is the most structurally complex, an enhancement on a deal we did for them in 1999 – their last public Tier 1 transaction. And both Friends Provident and CNCE are firsts of a kind: benchmark transactions where we were working with the regulators in a new regulatory framework and helping to set new standards.”

Media coverage also made the team’s job a little more difficult. Just before plans for the Friends Provident deal were announced, a story published in the Financial Times floated the idea that the markets could expect Ł4bn more issuance from insurers under the UK Financial Services Authority’s (FSA) new regulatory capital requirements. “It certainly caused a challenge from a marketing perspective. If investors believed there was a lot more paper coming from insurance companies, then it could affect the pricing.”

Investor participation

The response from the investor community pushed any marketing challenges they had experienced into the background, however. Investor participation rates on all three transactions were almost unheard of. “It’s very rare to see such consistently high participation,” says Mr Hoveyda.

There were more than a few regulatory hoops to leap through en route to execution to avoid the fate of Barclays Capital: early last year the FSA withdrew its approval of the firm’s Tier One Notes (Tons), saying the tax deductible Tier 1 debt had to be counted in the 15% of a bank’s Tier 1 capital that is allowed to be innovative. The regulator must also have been careful to avoid the ignominy of making a U-turn over the acceptability of a new structure.

Novel structures

These were novel structures and this made the approval process much longer. The Friends Provident transaction is the first tax-efficient Tier 1 offering for a UK insurer.

“We knew the structure we wanted – a debt instrument that carried the same loss absorbency as a preference share – but regulatory approval is the key ingredient. We had been working with the regulators since the summer. It’s an iterative process to gain the approval from policy and line supervisors,” says Mr Winstanley.

In France, too, the UK’s experience had helped to create a sensitive regulatory environment. “The FSA’s experience has made all European regulators cautious about approving new structures,” says Mr Hoveyda. “[The French regulator] was very demanding about what it wanted to see regarding loss absorption, in particular, before authorisation. This was the heavy-lifting part of the CNCE execution.”

Many commentators are predicting a flood of interest following Friends Provident’s benchmark sterling issue, believing it creates a blueprint in the UK for insurance companies seeking to raise Tier 1 capital under the forthcoming regulatory framework. But the team is keeping tight-lipped about whether Merrill has secured more insurance business on the back of the deal. “We’re working on it,” says Mr Hoveyda.

So, is anyone close to finding the Holy Grail of Tier 1 capital: a core capital product that passes muster with both regulator and ratings agency, is tax deductible and appeals to institutional and retail investors alike? “If our clients had needed to do these deals outside the innovative basket, we would have done it,” says Mr Winstanley. “Come and see us next year.”

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter